By Russ Banham
Carrier Management
Now that the dust has settled following the historic merger of giant broker Marsh and Jardine Lloyd Thompson, the transaction’s impact on the two firms’ reinsurance broking units, Guy Carpenter and JLT Re, is resetting the table for all reinsurance brokers.
Guy Carpenter, as the merged reinsurance brokerage entity will be called, has fortified its position alongside Aon Reinsurance Solutions and Willis Re as the Big Three. The trio of reinsurance brokers effectively dwarf the capital size and clout of competitors. However, since the merger between the parent firms is predicated in part on acquiring economies of scale through labor attrition, the likelihood is that many former employees of both reinsurance brokers are (or will be) available for hire.
These skillsets include mid-level and higher-ranking executives, as well as line brokers with longstanding, lucrative client relationships. Assuming smaller competitors snap up this talent, the opportunity exists to enhance operations and bulk up market share to boot. “There’s a large amount of people leaving and going elsewhere,” said Toby Esser, chairman of Next Generation Group, holding company for AFL Insurance Brokers.
Certainly, this has been the case at the reinsurance brokers’ parent firms. In May, Marsh sued rapidly growing competitor NFP Corp. over the hiring of 13 former JLT employees a few days before the transaction closed. It has been reported that Marsh/JLT is struggling with some personnel fallout. Mark Flippen, a JLT Specialty USA senior vice president, recently hired on as a managing director in the financial institutions group at NFP. Previously, Andrew Pelzer, a former JLT vice president, joined NFP’s M&A transaction liability practice, and Doug Turk, JLT’s prior chief marketing officer, signed on as the firm’s regional property/casualty managing director. Other former JLT personnel also have joined NFP, while several JLT brokers are now working at Alliant, including Justin Riccio, Kathryn Carroll, Carrie O’Neil and Ryan Farnsworth, among others.
At least one major employment migration from Guy Carpenter has been reported: the exit of David Flandro, former global head of analytics at JLT Re.
Guy Carpenter and Marsh both declined requests for an interview on the subject. However, in a July 31 call with analysts to discuss second-quarter results, Marsh CEO Dan Glaser said that while he was pleased with the merger’s post-transaction integration, the firm was tracking the retention of key talent at a high level.
Industry consolidation is nothing new, and neither is the departures of skillsets both prior to and after a merger or acquisition. There are many sound reasons why the alignment of Guy Carpenter and JLT Re makes sense, including marginal overlap of business globally, although some overlap is expected in the London market. “Added up, there isn’t much overlap in their respective clientele, adding value to the merger,” said Anthony Diodato, a managing director at A.M. Best.
There also appear to be opportunities to achieve significant economies of scale. Marsh expects to release between 3 percent and 5 percent of the combined entity’s workforce, or more than 3,750 employees. Neither Marsh nor Guy Carpenter have stipulated what percentage of the attrition will occur at the reinsurance broking unit.
In the July 31 call with analysts, Glaser and Guy Carpenter CEO Peter Hearn fielded questions about the merger. Their comments focused primarily on the post-transaction integration challenges and the value presented by the merger for clients. With regard to reinsurance, Glaser noted across-the-board firming of the market, good news for reinsurance brokers with commissions and fees dependent on pricing upswings. However, the second quarter did see a dip in the new Guy Carpenter’s revenue growth. “JLT’s new business slowed considerably during the series between deal announcement and closing,” Glaser said, adding that he is “confident in the long-term growth outlook for our combined business.”
Despite the upbeat prognosis, several industry observers weighed in on major challenges ahead for Guy Carpenter, involving talent retention and the possibility that some insurance carriers, anxious over the increasing clout held by the Big Three, will bypass the intermediaries and deal directly with reinsurers. “If you’re a carrier and the reinsurance brokers keep getting bigger, they in essence have more power and leverage to negotiate against you,” said Robert DeRose, a senior director at A.M. Best. “I don’t see how that could be a good thing for carriers.”
Is Bigger Better?
DeRose touches on a sensitive topic. Certainly, the mergers that produced Aon Benfield, Willis Re and Guy Carpenter appear justified by the difficulties the reinsurance brokers have had generating top-line revenues, which have been flat to down a bit for a number of years. As the balance sheets of insurance companies grow, there is less need for reinsurance, DeRose said.
Less need for reinsurance translates into smaller reinsurance brokerage commissions. “When you are limited in growing business organically, part of the rationale for a merger is the ability to obtain a bigger share of the market,” DeRose said.
While a larger market share is now the case, Guy Carpenter experienced a negative second quarter attributed principally to a constriction in new business. JLT Re had a similar falloff in the period between the deal’s announcement and its closing. Glaser commented at the quarterly earnings call that the combined reinsurance broking unit’s focus over the next couple of years will be on the bottom line. “There’s quite a spread between respective margins in the businesses,” he said.
Obviously, when one firm buys another firm’s business, larger revenues result. The attrition that typically follows pushes margins higher. “When organic growth is difficult to come by, the best way to improve your earnings is to acquire a competitor,” Esser said. “Frankly, the consolidation of reinsurance brokers has really been going on for quite some time. Very few independent brokers are left compared to 10 years ago.”
Other industry observers agreed. “We’ve been in a period of insurance intermediary consolidation for several years running now,” said Robert Hartwig, a professor of finance and insurance industry expert at the University of South Carolina’s Darla Moore School of Business. “And we are likely not done yet.”
The market loss of even a single reinsurance broker is not the best news for some carriers. “These deals are driven by economies of scale and the cost reduction this produces, which is good news for the reinsurance brokers involved,” said Hartwig. “But for carriers it reduces the opportunities to shop around their business to get the best possible deals in a growing global reinsurance market.”
He is referring in part to the newer non-traditional players assuming risks from carriers, such as capital markets alternatives to reinsurance like insurance-linked securities and special purpose vehicles like sidecars. “Today’s reinsurance market is awash in competitors and capital,” Hartwig said, “but all this business now has to go through a narrowing bottleneck because of fewer reinsurance brokers. As an economist, I can unequivocally state that this is bad for competition.”
Another reason inducing reinsurance brokers toward a merger is the growing size of large insurance companies, which has caused a reduction in their need for reinsurance. “Over the last few years, we have seen significant consolidation among primary insurers—the case with Hartford buying Navigators and ACE and Chubb merging, among other deals,” said Taoufik Gharib, senior director at S&P Global Ratings. “As carriers become much bigger, with multiple subsidiaries around the country and the world, they’re beginning to purchase reinsurance at the holding company level. Several insurers have even created a new function to handle this task: the head of ceded reinsurance.”
Their job is to scrutinize the company’s need to transfer as much risk to reinsurers and the capital markets, Gharib said. “Instead of buying ‘x’ amount of reinsurance for each subsidiary, large carriers can consolidate the purchase on a global basis at the enterprise level, which is more efficient and cost-effective,” he explained. “By closely looking at the structure of the reinsurance towers, you can optimize where you buy reinsurance or insurance-linked securities, resulting in less of a need to buy as much reinsurance as before.”
Other factors compelling reinsurance brokerage consolidation include the cheap cost of debt and the high cost of providing value-added client services like risk modeling and related analytics. “With the increasing dependence on modeling and analytics, which are expensive, smaller brokers are squeezed,” Esser said.
In response to these pressures, bigger seems to be better. But how big is a matter of acrimonious debate. The proposed $24 billion merger between Aon and Willis Towers Watson earlier this year is a case in point. Although both firms reportedly discussed the merits of combining, their plans broke off the day after they were revealed, causing a 7.8 percent decline in the value of Aon shares. The primary reason for the swift change in mind was the strong likelihood of regulatory pushback over the size of the combined entity and related antitrust implications. “International condemnation of the deal was the deal breaker,” said Hartwig, citing the duopoly that would result in a market with two gigantic brokers.
JLT, of course, is smaller than Marsh, although the transaction lifts the broker back into the industry’s top spot, formerly held by Aon. JLT Re also is smaller than Guy Carpenter. Nevertheless, the combined firm is in a better position to provide value-added services to large and growing carriers. “Because of their size now, they’re able to provide more sophisticated services to ceding carriers in dealing with the larger reinsurers,” he said.
In January, Guy Carpenter announced in a press release the development of a new Global Capital Solutions Group to “deliver powerful services, solutions and value to clients.” At the second-quarter analyst call, Glaser said the firm recently won an RFP by a top-10 U.S. insurer “leveraging a terror model developed by JLT Re combined with the analytical capabilities of Guy Carpenter.”
That’s good news for the large unnamed insurer. But what about smaller carriers and regional insurers? Gharib asserted that consolidation of reinsurance intermediaries is not exactly in their best interests, as they don’t have the size and clout to command attention by the Swiss Res and Munich Res of this world. Some carriers may decide to do business with direct reinsurers like General Re, bypassing the intermediaries altogether.
“If I were the CEO of a major insurance company, the fact that reinsurance brokers are consolidating means I need to find other ways to be sure my business is being appropriately shopped,” said Hartwig. “I owe it to my board and shareholders to pay closer attention to pricing and the margins the brokers are taking. Consequently, it is up to me to check out alternative channels, like dealing directly with a reinsurer or the capital markets.”
On the other hand, there are plenty of nimble reinsurance intermediaries left in the market that can structure innovative ceding transactions. And in some cases, they’re likely picking up skillsets from Guy Carpenter and JLT Re to do it.
Yours, Now Mine
Since Guy Carpenter declined Carrier Management’s interview request, there is no way to know how many people the firm has let go or who left on their own volition.
Glaser touted the “mountain of talent” still at the new Guy Carpenter to overcome “revenue headwinds” and “deliver interesting solutions” to clients in coming years. Certainly, a not insignificant number of people in mid-level and higher ranks from Marsh and JLT have left the building; perhaps a comparable percentage of executives and brokers have departed the reinsurance brokerage. “In any merger, you try to keep the best of both companies, but unfortunately some very talented people have to go, and other talented people decide to leave,” Gharib said.
Esser confirmed that AFL has hired several former mid-level executives from JLT Re —”a mixture of wholesale brokers and facultative reinsurance brokers”— and is looking to hire others. He added that most of the new hires voluntarily left the firm. “As a startup, we’re looking for relatively young but not too young experienced brokers to get things done,” he said. “Facultative right now is a big opportunity for independent brokers to help the ceding companies, and we expect it to grow. Treaty is more complicated because of the analytics and modeling.”
DeRose agreed that the integration of Guy Carpenter and JLT Re gives “smaller shops an opportunity to pick up talent at the senior and brokering levels,” he said. “This is a relationship business. A broker in the field will have contacts in the underwriting department of a carrier and in some cases with the CFO and even the CEO. When they leave the big broker because of a merger or acquisition and go to a smaller broker, they bring that relationship with them. The smaller broker now has a conduit to that business.”
As Diodato said, “Whoever has the customer locked up in a relationship, the better. The more deeply the hook is in that customer, the better the chance you’ll hold onto it.”
Russ Banham is a Pulitzer-nominated financial journalist.